S&P Report Notes Emerging Securitizations are ‘Complementary’

September 15, 2004

A report, published by Standard & Poor’s Ratings Services, indicates that “the emerging insurance securitization market is not being used as a substitute to traditional reinsurance, but instead is increasingly being utilized as a complementary form of risk transfer or as a capital planning tool.”

S&P noted: “Insurance securitizations have long been viewed as an alternative form of risk transfer to reinsurance, with insurers ceding their risks to the capital markets in order to improve financial flexibility, reduce concentration exposure, access cheaper financing, increase capacity, and better match assets and liabilities. However, evidence shows that the evolution of insurance-related capital market transactions is not cannibalizing the reinsurance market as previously feared, but is providing it with new opportunities. Reinsurers are using the capital markets to provide cheaper and more innovative solutions by combining traditional products with structured techniques.”

The rating agency called attention to reinsurers’ capital structure as being the key to their involvement in insurance securitizations. The report noted that as “the capital markets have lower return expectations than a reinsurer’s own target ROE or hurdle rate, reinsurers can reduce the cost of capital embedded in their products.”

“Securitization deals are benefiting reinsurers by allowing them to concentrate on offering products with higher risk-adjusted returns in conjunction with well-understood and manageable risks,” stated S&P credit analyst José Siberón. “In addition, reinsurers are taking advantage of innovations in the capital markets to broaden their product offerings and create new products with lower financing costs.”

S&P noted, however, “while reinsurers’ active role in insurance securitizations has staved off the competitive threat once posed by the capital markets, securitization remains a developing science in the context of reinsurance. Although new types of insurance asset-backed deals are emerging year on year, the volume of business remains small relative to the global reinsurance market.

“Total issuance for insurance-related structured finance securities rated by Standard & Poor’s amounted to $12 billion between 1999 and June 2004, compared with net reinsurance premiums written of $163.5 billion in 2003.”

The primary explanation for the comparative lack of growth, according to S&P, are the “structural challenges associated with insurance securitizations,” which inhibit the growth of the market. “Structured solutions can affect ceding companies’ financial leverage position, some insurance contracts are unfriendly to the capital market tradition of timely payment and could create risk to investors, legal risks associated with the convergence of the markets can be difficult to resolve, and the cost of transactions remains high relative to traditional reinsurance,” Siberón explained.

The report, “Insurance Securitizations: Complementing Traditional Reinsurance”, is available to subscribers of RatingsDirect, Standard & Poor’s Web-based credit analysis system, at www.ratingsdirect.com. Ratings information can also be found on Standard & Poor’s public Web site at www.standardandpoors.com; under Credit Ratings in the left navigation bar, select Find Ratings, then Credit Ratings Search. The report is also availabe through S&P’s U.S. and international offices.

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